The Netherworld of Investing

On the one hand, investors, who want to be successful, are entreated to do their homework, act on their convictions and have the courage to stay the course. On the other hand, investors are also admonished to take their losses quickly. In between those two places is a netherworld of self doubt(you could call it "no hand land"). I'm embarrassed to admit it, but I find myself in that Netherworld more often than not. At what point in time are you being patient and courageous v. being stupid and undisciplined? I think that is why it is important to define your risk/reward prior to entering into a position--meaning that you clearly state how much you are willing to let your courage and conviction cost you in terms of loss of capital and sleepless nights.

When I beat myself up about not being any better at mastering these things, I'm reminded of Albert Einstein. As you know, he developed a number of different theories, the Theory of Relativity being the most well-known. (He was also a womanizer, but I do forgive that in men who make great contributions otherwise). So radical, so unthinkable was this concept of relativity that there was a movement among several classical physicists to have his idea censured. Einstein was was not deterred by this dissent against his work. That is conviction and courage in action.

However, when quantum physics emerged, Einstein was not an early adopter, but rather a critic. Now this is what I find the grand paradox of conviction. At what point are your mired in the comfort of your old though previously brilliant, innovative ideas to the extent that you FAIL to embrace a newer, more brilliant, innovative idea such as quantum physics.

My conclusion is that if someone such as Albert Einstein had trouble with this, then it is okay for me to struggle with it as well--but quantify what I'm willing to pay or not for that conviction so that my capital does not evaporate and become dark matter of the universe.

Perhaps someone will invent "Quantum Investing"!

Adobe Reader 8

If you have not upgraded (free) your Adobe Reader to v. 8 then you are missing out on two terrific functions:

(1) Searchable text
(2) Text selection (that you can cut and paste).

Extraordinary functionality that has been added over previous versions.

Counterparty Risk

Whatever happens with respect to all of this structured debt obligations/financing, there are a few concepts that are important. Again, remember, I'm introducing myself to these concepts--you probably understand them better than I. But I'm approaching this as a tutorial to enable my understanding of these issues as they unfold.

Here's Counter Party Risk Definition

"A counterparty is a party with which a transaction is done. If A sells something to B, then B is a counter-party from A's point of view and vice-versa.

The risk that the counterparty will fail to fulfil their obligations - usually either by failing to pay or by failing to deliver securities - is called counterparty risk.

There are a number of ways of controlling counterparty risk. Some are trading mechanisms such as DVP or the use of a central counterparty.

Financial institutions should track and manage counterpart risk in much the same way as any other credit risk, and this should be integrated into institutions' overall risk management system.

The counterparty risks from securities trading are either simple credit risks (where the risk is that the other party will not pay) or a combination of credit risk with the risk of a position in a derivative (where the risk is that the other part will not deliver securities).

Counterparty risk tends to be at least as much of a concern to regulators as to the institutions exposed to it. This is because a large financial institution will be a counterparty to many others, and therefore the knock-on effects of its failure pose a systemic risk."

Tiny URL

Given the limitations of the comments section which give an annoying truncation of links, I've put a tinyurl button on the right.

Sunday Hare Scramble

Here's my son Reade. He is 16 today. Also for the first time he ran a hare scrambles. Tough stuff. Neither he nor his bike looked like this when he finished. There were a couple of mud bogs. Thank goodness for the power washer. The track was 4 loops of a 7 mile trek. He made it half way through having crashed pretty hard.

It's a pretty intimidating race. It was fun to watch him compete. I hope that he does it again.

Million Dollar Porfolio

Okay, why not. I'll post my portfolio just for the heck of it. I have everything in ANPI which has taken a lickin'--I figure it cannot go down any lower, but I could have had that conversation with myself at any point within the last year.

Book Recommendation

I like to read, and I detest having "hang time" when I have nothing to read. And the second worst thing is to HAVE something to read, but nothing to write or highlight with.

If you read no other book this year, read this one:

The Only Three Questions that Count (Investing by Knowing What Others Don't), by Ken Fisher.

I've not finished the book (I'm on page 73), but I'm comfortable recommending your buying it. Why? Because this book will help you turn your perspective inside out as well as amplify it. It will help you CHALLENGE your thoughts, uncover your biases. That challenge alone is more than worth the price of the book. It takes a whack of some of the much-vaunted mythologies and suggests a different tilt. You will find it both refreshing and informative. I say this having a bias AGAINST all things ubiquitous (Oprah, American Idol, stock news regarding KRY, Jim Cramer....). Few are more ubiquitous than Ken Fisher...but listen to him; I think that he has something worthwhile to say and well worth your time to hear.

----------------------------------------
04.01.07: Here is Steve's review
I wasn't able to get to the link in the comments. Thanks Steve!

Some Mortgage, Housing, Consumption Data

I have long been concerned about the continued resiliency of the consumer. And, as you have seen here over the last few weeks, I've had this perverse fascination with the activity and effects in the mortgage market. You can imagine my nirvana-like feeling when I found this paper

FEDERAL RESERVE BANK OF SAN FRANCISCO WORKING PAPER SERIES Innovations in Mortgage Markets and Increased Spending on Housing Mark S. Doms Federal Reserve Bank of San Francisco John Krainer Federal Reserve Bank of San Francisco

that speaks to some of the things that I've been concerned about. (Remember, you can always find learned opinions to support your point of view. It doesn't mean that you are right, merely that you have good company).

There were a few things that I wanted to share with you:

First, let's look at the increase in homeownership and housing prices:
I will profess a little surprise that the housing stock (which I take to mean available homes=existing plus newly build) % to be as low as it was. I conclude, perhaps erroneously, that the percentage of new housing to existing housing--though great in absolute numbers--is small in relative percentage. Nevertheless, the increase in homeownership is impressive.

Second, and a bit unrelated to my overall purpose, but a statistic that I think deserves some airtime is the amount of employment in the mortgage banking sector.


You might expect that the slope of the employment line would be steeper, but one of the points in the paper was the amount of productivity increases:

"Most recently (mid 1990s to mid-2000s), technology has played an important role in stimulating these changes in the mortgage market by improving the ability of lenders to gather and process information. Consumers now appear to face lower costs for obtaining mortgages, refinancing existing mortgages, and extracting home equity; a better ability of mortgage issuers to measure and price the risk of mortgage applicants; and a greater array of mortgageinstruments from which consumers can choose."

The third schedule shows the the the increase of MBS's in private conduits. You know why I'm interested in that !!!!

The slope of this curve is astounding.

But also consider this little ditty (I've added the underlines):

"As the down payment constraint is eased, housing consumption increases monotonically. Moving from a down payment rate of 20 percent to 10 percent results in a 24 percent increase in the quantity of housing purchased. As can be observed on the left-hand scale of Figure 5a, this increase in housing consumption also accompanies an increase in total lifetime utility. Not surprisingly, the easing of constraints makes households happier. However, the increase in housing consumption comes at the expense of non-housing consumption."

Finally, here's the table that reflects the relationship of housing expenditures on consumption.


As you know, there has been much discussion about the resiliency of the consumer. My sense of it is that the consumer is reaching the saturation of point of consumption. The salient points in this paper (to the extent that I understand them correctly) are

• Mortgage innovations have allowed people to buy more house than they would otherwise (though I will concede that "more" house may solely be to buy the inflated cost of a house they would have purchased more cheaply otherwise).
• Housing expenditures increase at the expense of other consumption
• The percent of homeowners has increase dramatically over the last few years

How can any of this mean that the consumer can continue at his/her currently sustained pace? I don't think that they can.

Mortgaged Back Securities--Bankruptcy Risk

I found this clause in the GS S-3 registration
What is says to me (and I'm not lawyer nor do I play one on TV) is that in
the event of a bankruptcy (think New Century), that the
loans might end up the property of the issuing entity. What does this mean?
I think that it means that these loans could be grabbed by the creditors
of the sponsor (such as New Century)and the certificate holders will be left
high and dry.

Let's watch the news for these items.  I cannot stress how critical this clause
is--and I'm not sure how remote a probability such action could/would be.
Here's an interesting conflict of interest.  You have Morgan Stanley (or any
other mortgage banker) who has securitized these notes and they are
left holding the bag for warehouse loans.  How do you think THEY would want
a bankruptcy judge to rule? I think that they would want the judge to rule
these loans as assets of the depositor (e. g. New Century) so they can get their
loans paid from the proceeds of the loans.  Very strange circumstances, you think?




Bankruptcy of the Depositor or the      The depositor and the sponsor may be
Sponsor May Delay or Reduce             eligible to become a debtor under the
Collections on Loans                    United States Bankruptcy Code. If the
                                    depositor or the sponsor for the
                                    certificates were to become a debtor
                                    under the United States Bankruptcy Code,
                                    the bankruptcy court could be asked to
                                        determine whether the mortgage loans
                                        constitute property of the debtor, or
                                        whether they constitute property of the
                                        issuing entity. If the bankruptcy court
                                    were to determine that the mortgage
                                    loans constitute property of the estate
                                    of the debtor, there could be delays in
                                    payments to certificateholders of
                                    collections on the mortgage loans and/or
                                    reductions in the amount of the payments
                                    paid to certificateholders. The mortgage
                                    loans would not constitute property of
                                    the estate of the depositor or of the
                                    sponsor if the transfer of the mortgage
                                    loans from the sponsor to the depositor
                                    and from the depositor to the issuing
                                    entity are treated as true sales, rather
                                    than pledges, of the mortgage loans.

                                    The transactions contemplated by this
                                    prospectus supplement and the related
                                    prospectus will be structured so that,
                                    if there were to be a bankruptcy
                                    proceeding with respect to the sponsor
                                    or the depositor, the transfers
                                    described above should be treated as
                                    true sales, and not as pledges. The
                                    mortgage loans should accordingly be
                                    treated as

                                  S-22

---

property of the related issuing entity and not as part of the bankruptcy estate of the depositor or sponsor. In addition, the depositor is operated in a manner that should make it unlikely that it would become the subject of a bankruptcy filing. However, there can be no assurance that a bankruptcy court would not recharacterize the transfers described above as borrowings of the depositor or sponsor secured by pledges of the mortgage loans. Any request by the debtor (or any of its creditors) for such a recharacterization of these transfers, if successful, could result in delays in payments of collections on the mortgage loans and/or reductions in the amount of the payments paid to certificateholders, which could result in losses on the certificates. Even if a request to recharacterize these transfers were to be denied, delays in payments on the mortgage loans and resulting delays or losses on the certificates could result.

Entry from My Notebook

I keep a notebook. I really cannot remember a thing, so writing is a good mind helpmate.

The Economist Magazine had this on it's front cover on 02.10.07:

"Next Stop Iran"

"There is a real possibility that George Bush will order a military strike on Iran sometime before he leaves the White House Two years from now."
---------------------------------------------------------------------
I don't post this to engage in a political conversations. Merely to post a former entry on a currently contemporary matter. While it is easy for us to be dismissive of other countries, I could imagine being part of a government of a country and bristling being told what I could or could not do. We don't really have a clear perspective of that in our country, for we seem to do whatever we want. Acting unilaterally, whether as a person or a nation doesn't win you many friends.

I generally try to not engage in political conversations. I have a neighbor who told my husband that "Leisa doesn't like George Bush because she's just jealous that she didn't go to an Ivy League school." This is why I don't like political and religious conversations, for there (shall I say oftentimes?) seems to be a decided break from discussing the point at hand to a diatribe against the person holding the opinion. Nearly one of the nuttiest things that I've heard said about me.

For the record, I've never had a conversation with this neighbor about George Bush or my like or dislike of him. Moreover, I've never given any consideration to the fact that I did not graduate from an Ivy League school. I've earned a terrific living without that credential. I think, though, that I earned some points when Mark indicated that I received the New Yorker (after my neighbor began to describe the magazine to my husband and Mark said, "Oh, Leisa subscribes to that."). He was dumfounded. Isn't that just stupid that he would be dumfounded? As you can probably guess, my neighbor is a little on the pompous side.

[deep sigh]

Fed Map

The Federal Reserve (various places) publishes much interesting stuff. Why don't you take a moment and visit some of the sites. I've created a link under the Info Mosaic. I'm trying to figure out how to put a little more pizzaz in my sidebars, but I don't know how to write code. I want to create a discrete "resources" guide as opposed to to blogs that I enjoy visiting.

Anyway, at least I'm trying to put some "labels" to organize some of the content. It's hard to believe, but I started this blog on October 1 and it has almost been 6 months, now since I've been at it!

Inflation Tutorial

Inflation Tutorial...courtesy of FinancialSenseOnline. I highly recommend your listening to it.

Steelcase--Part III

Headline News:

"NEW YORK (Reuters) - Steelcase Inc. (SCS), the world's biggest office furniture maker, said on Thursday quarterly earnings tripled, helped by growth in its international business.

Fourth-quarter net income rose to $29.3 million, or 20 cents a share, from $9.3 million, or 6 cents a share, a year ago.

Revenue rose 5.4 percent to $779 million.

The Grand Rapids, Michigan-based company said it expects first-quarter earnings of 15 cents to 20 cents per share including special items.

The company sees first-quarter revenue up 6 percent to 10 percent."

----------------------------------------------------------------------------
Net income includes 11.6M in "ex-items" or 40% of the net income item is "stuff". You don't see that in the release, nor do you see the anomalous income tax rate.

Now, it really doesn't matter what I think. The market often does something quite different than what I think. But never buy or sell a stock off of the headline number. Read the company's release, not the headline. One of the most profitable stock purchases I ever made was BUCY. The stock was trading down, but I could see that their backlog had increased tremendously. Well as soon as the conference call started, the stock went ballistic.

SC's operating income was quite strong, but (1)in a slowing economy, (2) the juice that they've already received from international income, and (3) a resorting back to normal income tax rates, I'm guessing that they will not see these types of results in the coming year.

Steelcase--Part II

Well, they are up 2.38% as I write. I think it is from the headlines. Personally, I don't understand it. Top line growth is 6-8%. To me that is not great growth. Sure they are growing their earnings largely through international growth--income is strong, but a 14.5% tax rate over a normal tax rate of 35% or so--is a wee bit distorting, at least based on my understanding.

We'll see if there is some realization that the DJ headlines vs the meat of the release has caused some cognitive dissonance. Perhaps I'm just missing something!

Lone Star Technologies

Lone Star Technologies (LSS) is being purchased by US Steel

"United States Steel Corporation (X) is buying Lone Star Technologies (LSS) for $67.50 per share in cash or total consideration of $2.1 billion, a premium of approximately 39% to Lone Star's closing share price of $48.45 on March 28, 2007."

Lone Star is the last man standing with Maverick Tube, National Stainless, Hydril having already been purchased. These companies serve the oils services sector making tubing and other things needed to outfit drilling. I have owned them all.

Being so familiar with the industry and understanding the consolidation happening, I'm kicking myself a bit for not having a position in LSS. LSS was the weakest of all of the sisters, but one needn't be a rocket scientist to see the good probability of takeover. Simply put, they fell off my radar screen.

If I've come to learn anything is that your radar screen is your best friend--particularly when you have invested time in learning about companies as I had with this group. I made really good money off of them because they were a little known segment of the oil services. No one was talking about them, but I researched the segment and realized that they all gained through servicing all of the drillers. I also lost alot of money because I had call options that bit the dust, when the oil services sector tanked. Easy come. Easy go.

Companies fall in and out of favor. All of these tubers fell out of favor (to my dismay!). I remember Tim Knight having HYDL as a short and I warned on the consolidation in the industry and that I thought a short was risky. There is a place for fundamentals.

The second lesson, is that when stock become really really treat, they are in the bargain bin, not only for investors, but for potential purchasers. That happened to each of these suppliers over the past year. Cast in the bin--rummaged through and then proudly taken to the register.

The purchase price is just a hair off the all-time high.

Steelcase Results

Steelcase reported their results this a.m.


North American sales are flat for the quarter over quarter, though YOY sales grew about 6%. Herman Miller's sales actually increased 15% over the same period. Clearly North American sales have stagnated

SCS's international operations are going gangbusters.

"As a result of the tax valuation and reserve adjustments made in the fourth quarter, the company's full year effective tax rate was 14.2%, significantly lower than the previous estimate of 34% to 35%. The company believes its fiscal 2008 effective tax rate will be between 34% and 35%." [A nice windfall I might add!]

"Consistent with past practices, the company is not providing full year guidance but does expect to continue its improvements in profitability towards the achievement of its long-term operating income margin of 10%."

Overall, I do not think that these are good results and confirms to me a slowing of cap expenditures in the US.

MBS-S-3 summary

I had a thought of doing something that goes above and beyond my typcal nerdiness--The time requirement is great, so I may do it very selectively. That thought was to take all of LEND's securitizations an line the up so that you could see the evolution of the characteristics affecting these loans. Here's what I was thinking about in terms of format.

Unfortunately, the earlier formats were different, and these docs are a little cumbersome, but I plan to complete this for a few offerings. Here's something worth noting, in looking at the 2003-2 securitization, the % of baloons was only 5.46%. Also, the average loan size was 153.2K the overall pricnicpal was $416.8M--less than half of what you see here.

Gary K

"Everything that I see is ugly! I'm letting you that the rally attempt off of the low is a big fat balloon."

He expects that we'll test the previous low and will bounce. He's now bashing B. Bernanke which I don't like. Oh well...I'm married, so I know how to tune things out!

Today's Market Close

Steelcase...

another larger commercial furniture manufacturer report results tomorrow. It will be interesting to see if their results are similar to Herman Miller's. Interestingly, SCS stock has been strong--they were actually up the day that Herman Miller was blasted out of the water. I found that an interesting divergence. I bought some APR 17.5 puts on that day. Might be foolish; might be inspired.